“Will It End Very Badly?” Probably Not.

Editor’s Note: Guest contributor and early TechCrunch writer Steve Poland (@popo) currently is exploring raising a fund to join the “overcrowded” early stage investment market. His last contribution was The New Early-Adopter Addiction: Turntable.

Last week at David Kirkpatrick’s Techonomy conference, Sean Parker said “Little startups are ridiculously overfunded. The market is ridiculously overcrowded with early stage investors. This results in a talent drain, where the best talent gets diffused and work for their own startups.” VC Jim Breyer added, “And it will end very badly.”

Here’s what that might sound like to many veteran ears: “Ahh! Blubble!”

Times have changed. The web and mobile startup ecosystem of Silicon Valley has fully matured. Anyone can be an entrepreneur, and almost anyone can be an investor in startups. It previously required millions of dollars to fund a tech startup, and so they were mostly (now) big names in semi-established fields–Netscape, Google, Amazon, and PayPal, for starters. But this also sparked the Internet revolution. People interested in carving out their piece of this Internet revolution didn’t have many options, and so the talent pool centered around those big, multi-faceted names.

Venture captialists holding hundreds of millions of dollars held the sole responsibility of selecting those entrepreneurs that would lead the Internet revolution, since millions of dollars were needed for the most basic web infrastructure and to build an idea and achieve a product/market fit. Exits on these companies resulted in newly minted “tech” millionaires.

As the infrastructure of the Internet revolution was built out, the capital needs of smart new web companies reached toward zero. With capital needs lowered, but VCs still focused on large-scale investments and the resulting returns, angel investors (wealthy techies) started placing small bets, from their own wealth, on entrepreneurs. VCs lost their super status as super angels (like Dave McClure and Jeff Clavier), early-stage funds (including First Round Capital), and startup accelerators (such as TechStars and Y Combinator) gave entrepreneurs more access to smaller-scale capital, and more direct mentoring and personal investment. More startups got funded and found profitable exit strategies of their own, resulting in more millionaires, and then another bump in the number of angels.

Over time, that means that capital is no longer the primary competitive advantage for an investor. There are many, many more angel investors in the tech industry, writing checks to entrepreneurs they (hopefully) believe in. To Sean and Jim’s point, more people are starting their own startups instead of joining others, which is spreading out the talent pool in Silicon Valley and this flood of fresh capital is resulting in investor competition to invest in startups, resulting in higher valuations and speedier funding cycles. Early stage “Series A” valuations have surpassed the $4 million line and are now averaging in the $6 million – $8 million range.

A lot has changed over just a few years and the market has simply corrected valuations, increasing the averages. As long as these increased valuations sustain themselves through exit, then everything still works for investors. The scary part for veteran investors is that they know there still remains a limited pool of buyers to achieve an exit — and building sustainable independent private companies doesn’t work for a VC’s business model. A VC fund’s limited partner investors are expecting a 10-year investment with a cash return, not ongoing future cash dividends. The industry needs more private market liquidity opportunities (secondary markets, private equity firms, etc).

So what’s next in this cycle for Silicon Valley?

We’ll continue to see entrepreneurs and investors in Silicon Valley venturing into uncharted waters, where revenue models are an after-thought. The wide access to capital for entrepreneurs isn’t going away anytime soon, especially with a slew of tech IPOs on the horizon, which will create even more Gentlemen VCs. Venture capitalists that invest full-time will begin further diversification of their funds outside of Silicon Valley and into other startup ecosystems, where capital for web and software-based startups isn’t as readily available.

Today it is easier and faster for entrepreneurs to build products and create value than it was just a few years ago. Monetization platforms (advertising technologies, mobile platforms, virtual currencies, etc) are in place that allow startups to generate revenue. The entire ecosystem (mentors, talent, technology, capital) supporting entrepreneurs and startups has matured. All of these factors have reduced investor risk compared to a few years ago. Even if that risk is lessened by only a few percentage points, this has created a funding model of higher valuations that can still work for the growing ranks of angel investors.

This isn’t stupid money flying around in the Valley. These new Angel investors are the product of 15 years of industry experience, and many cycles, some of them quite harsh. These new investors are bringing a wealth of experience, success, failure lessons, and connections. If they are committed to mentoring these new startups into building real businesses (and not gambling in hopes of picking the next startup homerun), then this class of internet revolutionaries will be well groomed to build the next generation of job-creating brand names.

Here’s to the crazy ones.

[Image: wavebreakmedia/Shutterstock]